Illusive Public Offerings

Since nothing says “risk-on” like the IPO market, it’s no surprise that current “risk-off” conditions are crushing the market’s newest companies. This hostile environment will doubtlessly have far-reaching effects on Wall Street, which has been hugely profiting from the public offering boom, and Silicon Valley, which has propagated many of the new ventures.

The 10 largest U.S.-listed IPOs of 2015 are down about 25% from their offering price.

The falling fortunes of IPO stocks reflects a broad retreat from younger companies that have little, if any, history of profitability or revenue growth. The unreal valuations that so many large, private technology firms reached in private fundraising are also starting to tank, a shift easily attributable to the same sentiment.

There were no U.S. IPOs in January, the first month-long drought since September 2011.

Amid this miserable market, an outfit called Silver Run Acquisition Corp. just raised $450 million in an upsized offering. Here’s the real kicker: The private-equity-backed company has nothing going for it but a CEO who killed it in the U.S. shale-drilling boom. Nothing — no assets, no operations, no real organization. 2016’s biggest IPO is, in fact, a blank check for a named executive to go bargain hunting in the oil patch.

There have been no U.S. IPOs of energy-production companies in more than a year.

Turns out that “special-purpose acquisition companies” like Silver Run use stock offerings to raise cash, then hunt for acquisitions to spend it on. If they don’t find anything before time runs, they’re supposed to return the cash to investors. Sure. Blank-check companies were the real thing back in 2007 and 2008. It’s not too hard to imagine why they fell out of favor.

What the markets have been doing…

Stocks recorded two weeks of solid gains as investors appeared to welcome some good economic data and put aside concerns about slowing growth and financial stresses overseas. The so-called “decoupling” of stock prices from global economic trends lifted the larger-cap benchmarks out of correction territory — commonly defined as a decline of 10% or more from recent highs. The technology-heavy NASDAQ remains in a correction, however, as do most smaller-cap indexes.

The period’s economic data were actually mixed. Despite a weak reading on manufacturing activity, durable goods orders rose solidly in January, as did personal income and spending. Traders clearly took note of a solid rise in the core personal consumption expenditures index, widely viewed, we’re told, as the Federal Reserve’s preferred inflation gauge.

Index

Friday’s Close

Two-Week Point Change

Year-to-Date Change

DJIA

16639.97

+666.13

-(4.51)%

S&P 500

1948.06

+83.28

-(4.69)%

NASDAQ

4590.47

+252.96

-(8.33)%

Despite the solid rally in stocks and a slug of new issue investment grade supply, the U.S. Treasury market seemed to run out of steam just about where it started. The market got little clarity from FOMC members regarding rates, though the futures market is still pricing in less than a 50% chance of a hike in 2016. Municipal bond prices fell slightly, underperforming both Treasuries and the overall bond market. High-yield bonds produced gains, in no small part due a recovery in the energy sector.

Fixed Income

Yield

Two-Week Change

2-Year Treasury

0.81%

+0.10%

10-Year Treasury

1.75%

-(0.09)%

30-Year Treasury

2.63%

-(0.04)%

Bloomberg Corporate Bond Index

3.59%

+0.54%

30-Year Municipal Bonds

2.77%

+0.04%

A standstill would be an improvement…

Quote of the Week…

“Hedge funds believe they need to promise double digit returns to justify high fees, and yet if you add up the micro you’ll discover that over the next decade median hedge fund returns will be 1% to 2%.”– Eric Peters, CIO, One River Asset Management

Number of the Week…

$2 billion: The value of bonds backing the buyout of software firm Solera Holdings. That Goldman Sachs is struggling to sell the deal is another sign that the market for low-rated debt behind the takeover boom is beginning to crack.

What Fund Architects is doing…

While the U.S. market showed good movement over the last couple of weeks, most likely in response to steadier-than-expected oil prices and better-than-feared economic data, the near term still looks dangerous to us. In fact, we might take the opportunity to take a few gains in our consumer discretionary position off the table. Cash still looks good in this market.

We have to think the story of 2016 so far is the U.S. government market. Fortunately for the Fund Architect portfolios, we built a significant overweight in Treasuries early in January, as high as 35% in some models. The result has been a gain of around 8% in the allocation so far this year. While we’ve realized decent gains in our consumer staples position, most of our year-to-date out-performance has come from the Treasuries allocation. All of the Fund Architect models are firmly positive year to date.

As we look at the markets here at the end of February, Treasuries still look like the smart move. It might feel a bit counter intuitive, but we’ll hold on until our models say otherwise.

The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional. The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.